How does a nonprofit say "goodbye" to a departing founder or executive? A gift and farewell party usually are appropriate. Though not as much fun to plan, an exit agreement may also be called for. This legal document, usually developed by a nonprofit's board of directors, details the terms of a leader's departure. Here's why exit agreements are important and how you can ensure any agreements you prepare achieve their purpose.
3 Common Scenarios
First, understand the difference between exit agreements and separation agreements. In general, separation agreements protect employers from former employees taking legal action (for example, with a wrongful termination suit) or directly competing against them. Exit agreements, on the other hand, usually relate to a departing employee's compensation and continuing relationship with the employer.
Consider these scenarios that may call for an exit agreement:
Several factors will likely influence your decision to use an exit agreement and dictate its terms as well as other actions you take.
Financial resources. Usually, a nonprofit board approves exit compensation because it believes it's "the right thing to do." But even if your nonprofit can compensate a former employee right now, its financial position may change over time. You can ensure your organization has the financial resources to make a generous offer to your departing executive by awarding a lump-sum amount. However, if you decide to extend compensation payments over a certain period, have the agreement specify their source. It also should provide for discontinuation of payments if they jeopardize your charitable mission.
Private inurement risk. Paying a departing executive compensation could put your organization in danger of violating private inurement rules. These rules prohibit certain transfers of assets (particularly "excessive" compensation) from nonprofits to insiders or people who have significant influence over the organization. If the IRS deems such compensation unreasonable, it could impose fines and penalties on your nonprofit and on individual board members who approved the compensation package. In a worst-case scenario, your tax-exempt status could be revoked.
Stakeholders' reception. You need to think about how your nonprofit's stakeholders — donors, staffers, volunteers and charity watchdog groups — will react when they hear about the package you're offering a former executive. They may feel it's excessive or unnecessary and that the board's actions are suspect. So always remember that the terms of your agreement will become public. For example, you'll need to report any financial compensation on your annual Form 990. To protect against accusations that your board has acted improperly, make sure board meeting minutes record discussions about the exit agreement and justifications for the amount provided the departing employee.
Contract issues. A breach of contract is possible whenever an organization enters into a contract with another party. However, such claims brought against a nonprofit typically are excluded under liability insurance policies. Check that you have this protection in place.
Your nonprofit may want to provide a respected leader with a lasting farewell gift. But you must minimize the risk to your nonprofit by avoiding promises you can't keep — and by making any agreement as specific as possible. Your attorney can help you draft an effective contract. And your financial advisor can help you determine whether you have the financial wherewithal to make a generous offer.